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Securtization

Thread starter #1
In the 3 tier securitization structure there would be Senior tranch, mezanine tranch & equity tranch. Suppose there are enough cash-flow received (say A) from the underline security to pay off the interest to Senior (B) & Mezanine tranch (C) holder & remaining amount of (A-B-C) say K, So, here my question is the remaining amount of K would go first to equity holder or it would be transferred to trust account?? or it is the other way that K will go to equity first then the excess amount remained after paying the equity would go to the trust account?
 
#3
Hi intuitive...

The example in Malz ch 9 (tables 1 and 2) is very informative. The short answer to your question, IMHO, is that the trust account (which is the same as the o/c account I think) is funded first from any positive excess spread. Equity holders are last in the queue.

There is some max amount that can be set aside into the trust account using funds from the excess spread, call it M, so that if you can fully pay M into the trust account using the excess spread (so K > M), only then do equity holders get what's left.

Hope that helps :)
 
#4
EDIT:
I made an error in the case "Default, Default > S-OC". I've corrected it.

To add on to the answer given by k.simpson above, to achieve overcollateralization (protection), the securitization is setup in such a way that the income from the underlying pool per period is greater than the principal and interest payments to the senior and mezz tranches. Point here being, it is setup this way, doesn't just happen by chance.

Now to answer your question on what happens with the excess spread? To achieve further overcollateralization, a static amount will be diverted to an account (called overcollateralization or reserve account) and earn interest. The remainder of the excess spread is then paid out the equity tranche. Let's denote the excess spread as S and the amount to be diverted to the account as OC. If S < OC, then equity tranche investors get nothing in that period, and an amount OC is put into the reserve account. Equity investors will only receive funds if S > OC, and they will receive S-OC.

If there is a default, we go up the ladder of the securitization to try and absorb defaults. What does this mean?

case: Default, S-OC can cover the default

Equity investors get nothing that period and OC is deposited into the reserve account.

case: Default, S-OC = amount in default
Equity investors receive nothing, and no funds are put into the reserve account

case: Default, Default > S-OC, Default < reserve account total
Equity investors receive nothing, no funds are put into the reserve account and now we will use the funds in the reserve account to cover the default.

case: Default, Default > S-OC, Default > reserve account total
Equity investors receive nothing, no funds are put into the reserve account, we will use all the funds in the reserve account to cover the default and we start seeing defaults in the mezz tranche. If there are a lot of defaults in the underlying pool, mezz tranche could be wiped out and then we start seeing defaults in the sr. tranche.

At the maturity of the securitization, any funds left in the reserve account are paid to equity investors.
 
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